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Fixed Indexed Annuities
We believe that there is a lot of misinformation and confusion being spread regarding annuities.
There are several different types of annuities to choose from, and they are far from being created equally.
Firstly, there are two basic types of annuities: variable annuities and fixed annuities. Oak Harvest never recommends variable annuities. Period.
For some investors, we may recommend fixed indexed annuities (FIA), if appropriate for their particular situation, objectives and risk tolerance. We believe it is the only tool available to the retirement planner that can provide 100% protection against loss of principal, while at the same time providing growth potential by tracking an equity index, like the S&P 500. Some fixed index annuities may also have options that can provide a lifetime income stream.
If used appropriately for investors with specific needs and objectives, a FIA may be an effective tool in the retirement planner’s toolkit.
The Basics of FIAs
A fixed indexed annuity is a financial policy issued from a life insurance company. As a purchaser, you make deposits with the insurance company called premiums, and in exchange you receive a financial contract with certain guarantees, terms and conditions. The policy comes with a contractual guarantee that your principal is protected 100% from market risk. This means your money is always safe from loss — even if the market goes down.
A fixed indexed annuity earns interest by participating in the positive movement of a market index like the S&P 500. The specific returns generated will depend on the terms and conditions of the policy. However, the returns will never be negative because the annuity contract guarantees protection against market losses.
While fixed indexed annuities have 0 downside risk, the upside is usually limited by either a participation rate or a cap. Read more on participation rates and caps in our Annuity FAQ. Oak Harvest generally prefers policies that do not have a cap, though our specific recommendations are always based on the specific needs, objectives and risk tolerance of our clients.
Earning Interest and Lifetime Income
As you earn interest in an FIA, those gains are locked-in and can never be given back, even if the market index loses value. All future interest earned will compound on top of previous years’ interest. Different FIAs lock in interest gains at different times. Some FIAs lock-in gains annually. Some do it every two or three years.
Some FIAs have the option to provide a guaranteed lifetime income stream, so you never run out of "retirement paychecks." Some FIAs include this option as a choice at no cost; others may include this option via the addition of a rider to the policy, which carries an additional fee, often about 1%. We believe it is very important to work with a guide to determine which option is best for your situation. FIAs that offer lifetime income may help to guarantee that you will always receive an income stream until death.
In order to provide guaranteed protection of principal, optional lifetime income, and the ability to participate in the growth of a market index, the life insurance company must be able to accurately predict their assets and liabilities well into the future.
In order to do this, FIAs often have a surrender charge schedule. Surrender charges are a fee imposed only after policy owners withdraw more than a specified annual free withdrawal amount.
Many FIAs allow policy owners to access up to 10% of the account value each year, if needed, with no penalty. This is called a “free access provision.”
If more than 10% of the account value is withdrawn, a surrender charge is imposed. These charges are higher in the beginning years and usually decline 1% per year over the surrender charge period. At the end of the surrender charge period, which is often between six and 10 years, the money is 100% liquid and you have complete access to your entire account value without a surrender charge. Specific terms and conditions will vary by contract.
In the event you pass away during the surrender charge period, the charges are waived and your entire account value will pass to your named beneficiaries bypassing probate without incurring a penalty fee.
Because of the surrender charge provision, we believe that it is important to exercise care to not allocate too much money into FIAs. Liquidity is an important consideration in retirement, and we believe investors should never put too much money into any one strategy, including fixed indexed annuities.
Depending on your situation, an annuity may be a viable option for your retirement portfolio. Oak Harvest retirement professionals will sit with you and carefully examine your complete situation, leverage our Core4 planning approach, and make recommendations that we believe will give you a stronger probability of realizing your financial goals.
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